Chapter 7: Operating Assets Flashcards
the long-lived assets that are used by the company in the normal course of operations.
operating assets
Are operating assets sold to customers?
no ; they’re used by the company to generate revenue
The typical operating asset is used for a period of __ – ___ years.
4 - 10 years
What are the three categories of operating assets?
- Property, plant, and equipment (often called fixed or plant assets)
- Intangible assets
- Natural resources
operating assets that are tangible (can be seen and touched). They include, among other things, land, land improvements, buildings, and equipment.
property, plant and equipment (fixed assets)
operating assets that generally result from legal and contractual rights and do not have physical substance.
intangible assets
What are 5 examples of intangible assets?
- Patents
- Copyrights
- Trademarks
- Licenses
- Goodwill
naturally occurring materials that have economic value. They include timberlands and deposits such as coal, oil, and gravel.
natural resources
At acquisition, an operating asset is recorded at its cost, including the cost of _______ the asset and the cost of _________ the asset for use (historical cost principle).
acquiring; preparing
Operating assets are capitalized, which means what?
they’re reported as long-term assets with a service potential of greater than 1 year.
As the service potential of an operating asset declines, the cost of the asset is allocated as an _______ among the accounting periods in which the asset is used and benefits are received.
expense
Name the type of allocation of the cost of the asset for each type of operating asset:
1. PPE
2. Intangible Assets
3. Natural Resources
- Depreciation
- Amortization
- Depletion
T or F: operating assets are often the most costly type of asset acquired by an entity.
True
Information about a company’s operating assets gives financial statement users insight into what two things?
- A company’s ability to satisfy customer demands
- Effectiveness of management in using the company’s assets to generate revenue
What are 4 examples of property, plant, and equipment?
- Land
- Land Improvements (like driveways, parking lots, fences, lighting, etc.)
- Buildings
- Equipment
What has an unlimited life and service potential, and is not subject to depreciation?
Land
T or F: Land improvements, buildings and equipment have limited lives and service potential and are depreciated over the periods in which they’re used to generate revenue.
True
Expenditures that are included as part of the cost of the asset are said to be _________.
capitalized
For land improvement, cost usually includes what three things?
- Purchase price
- Sales taxes
- Installation costs
For land, cost usually includes what 6 things?
- Purchase price
- Real estate commissions
- Delinquent property taxes
- Closing costs
- Clearing and grading costs
- Demolition of unwanted buildings, minus any salvage
For buildings, cost usually includes what 6 things?
- Purchase price
- Closing costs
- Architectural fees
- Cost of building permits
- Excavation costs
- Remodeling fees
For equipment, cost usually includes what 6 things?
- Purchase price
- Sales taxes
- Transportation costs
- Insurance during transportation
- Installation costs
- Cost of trial runs
Generally, recurring costs that benefit a period of time, not the asset’s life, are (capitalized/expensed) instead of (capitalized/expensed).
expensed; capitalized
T or F: Unnecessary costs that don’t increase an asset’s usefulness (ex: vandalism, damage during installation) are capitalized.
False; they are expensed
requires that a company record its fixed assets at the exchange price at the time the asset is purchased. What principle is this? (true for recording the cost of a fixed asset)
historical cost principle
Companies often purchase fixed assets by ______ ______. In this situation, the asset is valued at the fair value of the liability on the date the asset is acquired.
issuing debt
Interest paid on the debt is generally viewed as resulting from a financing decision rather than from the decision to acquire the asset. So, interest on borrowed funds normally (is/ is not) added to the purchase price of an asset.
is not
When noncash consideration, such as land or stock, is given in exchange for an asset, the acquired asset is reported at the fair value of the consideration given or the fair value of the asset received, whichever is _____ _______ ______.
more clearly evident
the process of allocating, in a systematic and rational manner, the cost of a tangible fixed asset (other than land) to expense over the asset’s useful life.
depreciation
What would an adjusting journal entry for depreciation expense look like?
Depreciation Expense XXX
Accumulated Depreciation XXX
the amount of depreciation recorded on the income statement.
depreciation expense
the total amount of depreciation expense that has been recorded for an asset since the asset was acquired. It is reported on the balance sheet as a ______-______.
accumulated depreciation; contra-asset
the value of an asset or liability as it appears on the balance sheet; is calculated as the cost of the asset/liability minus the balance in its related contra account
book value
What is the equation for book value (or carrying value)?
Cost of the asset - accumulated depreciation = book value
Depreciation is a ______ ______ process. It’s not an attempt to measure the fair value of the asset or obtain some other measure of the asset’s value. In fact, the book value of an asset that is reported on a company’s balance sheet is often quite different from the market value of the asset.
cost allocation
T or F: Depreciation is not an attempt to accumulate cash for the replacement of an asset. Depreciation is a cost allocation process that does not involve cash.
True
What are the three things of information that is necessary in order to measure depreciation?
- Cost of the fixed asset
- Useful life (or expected life) of the fixed asset
- Residual value (salvage value) of the fixed asset
any expenditure necessary to acquire the asset and to prepare the asset for use.
cost
What is the equation for depreciable cost?
Cost of Asset - Residual Value = Depreciable Cost
the period of time over which the company anticipates deriving benefit from the use of the asset.
useful life
T or F: Many companies plan to dispose of assets before their entire service potential is exhausted (ex: car rental companies typically do this)
True
Useful life is also influenced by _________ ______ (assets can lose their service potential through _________ long before the asset is physically inoperable).
technological change; obsolescence
the amount of cash or trade-in consideration that the company expects to receive when an asset is retired from service.
residual value (or salvage value)
T or F: Since depreciation expense is based on estimates of useful life and residual value, it is also an estimate.
True
the amount that will be depreciated (expensed) over the asset’s useful life.
depreciable cost
the standardized calculations required to determine periodic depreciation expense.
depreciation methods
What are the three most common depreciation methods?
- Straight-Line Method
- Declining Balance Method
- Units-of-Production Method
For any of the depreciation methods, the total amount of depreciation expense that has been recorded (acc. depreciation) over the life of the asset will (sometimes/always/never) exceed the depreciable cost of the asset.
never
What depreciation method allocates an equal amount of an asset’s cost to depreciation expense for each year of the asset’s useful life?
straight-line method
What is the most widely used depreciation method?
straight-line method
What is the equation to calculate straight-line depreciation expense?
(Cost - Residual Value) / Expected Useful Life = Straight-Line Depreciation Expense
some companies will calculate an annual rate at which the asset should be depreciated. The fraction, (1 / useful life), is called ______ _____ _____.
straight-line rate
Using the straight-line rate, a company would compute depreciation expense by multiplying the straight-line rate by the asset’s ______ ______.
depreciable cost
Using the straight-line depreciation method, the contra-asset account, accumulated depreciation, (increases/decreases) at a constant rate per year until it equals the depreciable cost.
increases
an accelerated depreciation method that produces a declining amount of depreciation expense each period by multiplying the declining book value of an asset by a constant depreciation rate.
declining balance depreciation method
The declining balance method is called accelerated because it results in a (smaller/larger) amount of depreciation expense in the early years of an asset’s life relative to the straight-line method.
larger
The declining balance method results in (larger/smaller) amount of depreciation expense in the later years of an asset’s life.
smaller
The declining balance method is appropriate for assets that are subject to a rapid decline in _____ _______ due to factors such as rapid ___________.
service potential; obsolescence
How do you calculate Declining Balance Rate?
2 x Straight-Line Rate = Declining Balance Rate
How do you calculate Declining Balance Depreciation Expense?
Declining Balance Rate x Book Value = Declining Balance Depreciation Expense
Since the declining balance method doesn’t consider the residual value, it’s possible that the calculated depreciation expense in the _____ year would cause the book value of the asset to fall _____ its residual value. An asset should not be depreciated below its residual value. Therefore, the final year of depreciation expense is computed as the amount needed to ______ the asset’s book value to its residual value.
final; below; reduce
a depreciation method gauged by a measure of productive capacity (such as units produced, hours worked, or miles driven).
Units-of-Production Depreciation Method
The units-of-depreciation method is used when the decline in an asset’s service potential is __________ to the usage of the asset and that asset usage can be measured.
proportional
How do you calculate Depreciation Cost Per Unit?
(Cost - Residual Value) / Expected Usage of the Asset = Depreciation Cost Per Unit
How do you calculate Units-of-Production Depreciation Expense?
Depreciation Cost Per Unit x Actual Usage of the Asset = Units-of-Production Depreciation Expense?
Which depreciation method is less widely used? Why?
Units-of-Production Method; it requires estimating expected usage, which is more difficult than estimating useful life in years
The use of the straight-line method produces a (lower/higher) reported income in the early years of an asset’s life relative to the declining balance method. This (lower/higher) income may (increase/decrease) management bonuses and create a favorable impression to outside users which could result in (higher/lower) stock prices
higher; higher; increase; higher
Once a depreciation method is chosen, that method should be consistently applied to enhance ___________ of the financial information.
comparability
T or F: The depreciation method used in preparing its tax return needs to be the same.
false; does not need to be the same
The ________ _______ _______ specifies which depreciation method should be used by a company to prepare tax returns.
Internal Revenue Code
Tax depreciation rules enable companies to save cash by _________ the payment of taxes.
delaying
Most companies use the _______ _______ ______ _____ _______ (MACRS) to compute depreciation expense for their tax returns, which is similar to the declining balance method. → not acceptable for financial reporting purposes.
Modified Accelerated Cost Recovery System
expenditures that do not increase the future economic benefits of the asset; they are expensed in the same period the expenditure is made (such as ordinary repairs and maintenance of an asset).
revenue expenditures
Revenue expenditures (3 things):
- maintain the level of benefits provided by the asset
- relate only to the current period
- occur frequently, and typically involve relatively small dollar amounts
expenditures to acquire long-term assets or extend the life, expand productive capacity, increase the efficiency, or improve the quality of existing long-term assets.
capital expenditures
Capital expenditures typically involve (small/large) dollar amounts.
large
Because capital expenditures provide benefits to the company in both current and future periods, they are added to a _______ account and are subject to _________.
asset; depreciation
What are 4 examples of capital expenditures?
- major repairs
- additions
- remodeling of buildings
- improvements (or betterments)
T or F: It’s often difficult to distinguish between capital and revenue expenditures.
True
If a company needs to adjust an asset’s useful life or residual value, it must revise _________.
depreciation
When a capital expenditure is made, it’s also necessary for a company to recalculate ________ _________. (In such situations, the company doesn’t change the previously recorded amounts related to depreciation. Instead, any revision of depreciation is accounted for in current and future periods.)
depreciation expense
Revisions of depreciation expense are accounted for in current and future periods following these steps (2):
- Obtain the book value of the asset at the date of the revision of depreciation.
- Compute depreciation expense using the revised amounts for book value, useful life, and/or residual value.
The book value of an asset and the fair value of an asset may be quite different. When the fair value of the asset falls significantly below the book value of the asset, the asset may be ______.
impaired
If a fixed asset is impaired, a company should ______ the asset’s book value to its fair value in the year the impairment occurs.
reduce
a type of disposal that occurs when a company determines that the asset is no longer useful; the disposal may occur at the end of the asset’s useful life or at some other time. (ex: obsolescence due to unforeseen technological developments may lead to an earlier than expected disposition of the asset)
voluntary disposal
a type of disposal that occurs when assets are lost or destroyed through theft, acts of nature, or by accident.
involuntary disposal
The disposal of property, plant, and equipment may require two journal entries:
- An entry to record depreciation expense up to the date of disposal.
- An entry to:
- Remove the asset’s book value (the cost of the asset and the related accumulated depreciation)
- Record a gain or loss on disposal of the asset, computed as the difference between the proceeds from the sale and the book value of the asset.
Gains and losses on the disposal of PPE are normally reported as “______ ______ or ______” or “_______ _______ or ______”, respectively, and appear immediately after _______ _____ ______ on a multiple-step income statement.
- other revenues or gains
- other expenses or losses
- income from operations
One measure of how efficiently a company is using its fixed assets is the ______ _______ _______ _____.
fixed asset turnover ratio
How do you calculate Fixed Asset Turnover Ratio?
Net Sales / Average Net Fixed Assets = Fixed Asset Turnover Ratio
The more efficiently a company uses its fixed assets, the (lower/higher) the fixed asset turnover ratio will be.
higher
Because older assets tend to be less efficient than newer assets, the age of a company’s fixed assets can provide useful insights into the company’s efficiency. The age of a company’s fixed assets also can provide an indication of a company’s capital replacement policy and assist managers in estimating future capital expenditures. A rough estimate of the AVERAGE AGE OF FIXED ASSETS can be computed as:
Accumulated Depreciation / Depreciation Expense = Average Age of Fixed Assets
assets that provide a benefit to a company over a number of years but lack physical substance.
intangible assets
What are 7 examples of intangible assets?
- Patents
- Copyrights
- Trademarks
- Leaseholds
- Organization Costs
- Franchises
- Goodwill
The economic benefits associated with most intangible assets are in the form of ______ ______ and _______ conferred on the owner of the asset.
legal rights and privileges
The economic value of a ______ is the legal right to restrict, control, or charge for the use of the idea or process covered by the patent.
patent
T or F: Intangible assets are recorded at cost, consistent with the historical cost principle. Like fixed assets, the cost of an intangible asset is any expenditure to acquire the asset and to prepare the asset for use.
True
For intangible assets purchased from outside the company, the primary element of the cost is the _______ ______.
purchase price
Costs such as registration, filing, and legal fees are considered necessary costs and are __________ as part of the intangible asset.
capitalized
For internally developed intangible assets, the cost of developing the asset is ________ as incurred and normally recorded as _______ ______ ______ ______.
expensed; research and development expense (R&D)
T or F: Current accounting standards require that all R&D be recorded as an expense.
True
the cost of internal development of intangible assets that is expensed as incurred.
research and development expense
significant costs such as legal fees, stock issue costs, accounting fees, and promotional fees that a company may incur when it is formed.
organizational costs
Organizational costs incurred in acquiring an intangible asset, such as legal fees, are _______ in the period in which they are incurred.
expensed
What two types of intangible assets are not amortized since they have indefinite life?
Trademark and goodwill
Once an intangible asset is recorded, companies must determine if the asset has a ______ life or an _______ life.
finite; indefinite
the process whereby companies systematically allocate the cost of their intangible operating assets as an expense among the accounting periods in which the asset is used and the benefits are received (what occurs for the cost of an intangible asset with a finite life)
amortization
Most companies will amortize the cost of an intangible asset on a _____-_______ basis over the shorter of the economic or legal life of the asset.
straight-line
If an intangible asset is determined to have an ______ life, it is not amortized but is reviewed at least annually for impairment.
indefinite
T or F: Most intangible assets do not have residual value. Therefore, the cost that is being amortized is usually the entire cost of the intangible asset.
True
Amortization expense is reported as _________ expense on the income statement.
operating
resources, such as coal or deposits, oil reserves, and mineral deposits, that are physically consumed as they are used by a company and that can generally be replaced or restored only by an act of nature.
natural resources
Natural resources differ from other operating assets in two important ways:
- Unlike fixed assets, natural resources are physically consumed as they are used by a company.
- Natural resources can generally be replaced or restored only by an act of nature. (ex: timberlands are renewed by replanting and growth, but coal deposits and most mineral deposits are not subject to renewal.)
At acquisition, all the costs necessary to ready the natural resource for separation from the earth are _________.
capitalized
As a natural resource is removed from the Earth, the cost of the natural resource is allocated to each unit of natural resource removed. This process of allocating the cost of the natural resource to each period in which the resource is removed from the earth (used) is called
depletion
How do you calculate depletion rate?
Cost - Residual Value / Recoverable Units = Depletion Rate
How is depletion calculated?
Depletion Rate x Units Recovered = Depletion
As the natural resource is extracted, the natural resource is ______ and the amount of depletion computed is added to _______. As the inventory is sold, the company will recognize an _______ (_____ ___ _____ _____) related to the natural resource.
reduced; inventory; expense (cost of goods sold)
Depletion (increases/decreases) the accumulated depletion account.
increases
a permanent decline in the future benefit or service potential of an asset (may be due to numerous factors, including too little depreciation expense being recorded in the previous years or obsolescence of the asset).
impairment
T or F: A company is required to review an asset for impairment if events or circumstances lead the company to believe that an asset may be impaired.
True
If a fixed asset is impaired, a company should (increase/reduce) the asset’s book value to its fair value in the year the impairment occurs. This is consistent with the principle of _______.
reduce; conservatism
The impairment test consists of two steps:
- Existence: an impairment exists if the future cash flows expected to be generated by the asset are less than the asset’s book value.
- Measurement: if an impairment exists, the impairment loss is measured as the difference between the book value and the fair value of the asset.
